Utility Debt Securitization Authority Restructuring Bonds, Series 2016B

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1 Utility Debt Securitization Authority Restructuring Bonds, Series 2016B CREDIT OPINION Pre-Sale Long Island Power Authority-Sponsored Utility Cost Recovery Bonds TABLE OF CONTENTS Capital Structure Summary Rating Rationale Credit Strengths Credit Challenges Key Characteristics Securitization Structure Characteristics Assets Overview Assets Description Assets Analysis Securitization Structure Overview Securitization Structure Description Detailed Description of the Structure Securitization Structure Analysis Methodology and Monitoring Estimated Closing Date June 2016 Contacts Arti Mattu Associate Analyst arti.mattu@moodys.com Sanjay Wahi VP-Senior Credit Officer sanjay.wahi@moodys.com Luisa De Gaetano Associate Managing Director marialuisa.degaetanopolverosi@moodys.com William Black MD-Structured Finance william.black@moodys.com Capital Structure Exhibit 1 Provisional (P) Ratings* The ratings address the expected loss posed to investors by the legal final maturity. In our opinion the structure allows for timely payment of interest and ultimate payment of principal at par on or before the rated final legal maturity date. Our ratings address only the credit risks associated with the transaction. Other non-credit risks are not addressed, but may have a significant effect on yield to investors. * Principal amounts and legal maturity dates are preliminary and subject to change ** Reflects the latest legal maturity date among the tranches in the series Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016, and Moody s Investors Service Summary Rating Rationale We have assigned provisional ratings to the single series of bonds (Series 2016B bonds, or the bonds) that Utility Debt Securitization Authority (the issuer) will issue. The Long Island Power Authority ( the Authority, Baa1 stable), which is a corporate municipal instrumentality and a political subdivision of the State of New York, is sponsoring the transaction. The Authority wholly owns the Long Island Lighting Company (doing business as LIPA, the servicer), which provides electric transmission and distribution services in most of Nassau and Suffolk counties and a portion of Queens county. New York State legislation formed the issuer to securitize a special charge (the restructuring charge) imposed on the Authority's customers' utility bills. The Authority will use the proceeds of the securitization to retire a portion of its outstanding debt. The Series 2016B bonds will be the fourth utility cost recovery bonds sponsored by the Authority since This pre-sale report addresses the structure and characteristics of the proposed transaction based on the information provided to Moody s as of 28 July Investors should be aware that certain issues concerning this transaction have yet to be finalized. Upon conclusive review of all documents and legal information as well as any subsequent changes in information, Moody s will endeavor to assign definitive ratings to this transaction. The definitive ratings may differ from the provisional ratings set forth in this report. Moody s will disseminate the assignment of definitive ratings through its Client Service Desk. This report does not constitute an offer to sell or a solicitation of an offer to buy any securities, and it may not be used or circulated in connection with any such offer or solicitation.

2 The primary collateral backing the Series 2016B bonds is the irrevocable contract right to impose, bill and collect nonbypassable consumption-based restructuring charges from all existing and future retail electric customers taking electric transmission or distribution service within the Authority's service area (the restructuring property). New York State legislation, along with an irrevocable financing order adopted by the Authority on June 26, 2015, authorizes the creation of the restructuring property. Our provisional ratings on the bonds reflect our assessment of (1) the strength of the State of New York s legislation including the State s non-impairment pledge, which strongly protects the restructuring property backing the bonds; (2) the strength of the Authority s irrevocable financing order authorizing the creation of the restructuring property; (3) the size, stability and diversity of the ratepayer base in the Authority's service area; (4) the ability and experience of LIPA, who is responsible for the billing and collection of the restructuring charges, as the initial servicer of the restructuring property, and of PSEG Long Island LLC (PSEG-LI), who will perform LIPA s key servicing functions; and (5) the credit enhancement supporting the bonds in the form of a mandatory uncapped true-up mechanism that periodically adjusts the restructuring charges to ensure timely bond payments until the bonds are repaid in full, a nondeclining operating reserve account and a debt service reserve account. Credit Strengths Strength of legislation and financing order: The State of New York s legislation (Part B of the LIPA Reform Act, or the securitization law), coupled with an irrevocable financing order that became final and non-appealable on August 14, 2015, permits the securitization and strongly protects the restructuring property securing the bonds. Similar to other utility cost recovery charge securitizations, this transaction benefits from the securitization law s inclusion of a state non-impairment pledge under which the State of New York pledges to bondholders that it will not (1) take or permit any action that limits, alters or impairs the value of restructuring property; or (2) reduce, alter or impair transition charges that are imposed, collected and remitted for the benefit of the owners of restructuring bonds, any assignee, and all financing entities, until any principal, interest and redemption premium in respect of restructuring bonds, all ongoing financing costs and all amounts to be paid to an assignee or financing party under an ancillary agreement are paid or performed in full, except as required by the adjustment mechanism described in the restructuring cost financing order (the state pledge). In addition, the securitization and financing order contain the typical true-sale and security interest provisions. The Authority s irrevocable financing order authorizes the Authority to recover specified costs of retiring its corporate debt by collecting restructuring charges. The restructuring property grants the issuer the irrevocable right to impose, bill and collect irrevocable, nonbypassable restructuring charges based on electricity usage, and related rights, including a mandatory uncapped true-up mechanism that periodically adjusts the charges to ensure timely bond payments until the bonds are repaid in full. Nonbypassable refers to the requirement that the charges be levied on all of the Authority's existing and future retail electric customers receiving transmission and distribution services in its service area, including customers of any Authority successor or assignee. True-up adjustment mechanism: The true-up adjustment mechanism is the key form of credit enhancement supporting the bonds. The financing order authorizes an uncapped true-up adjustment mechanism that mandatorily adjusts restructuring charges annually and, if necessary, semiannually, to ensure timely bond payments. In addition, the financing order authorizes more frequent interim adjustments at any time if the servicer deems necessary to ensure timely bond payments. The servicer may also elect to perform a voluntary mid-year true-up adjustment to decrease charges to customers to correct for overcollections in any year (in addition to the requirement that the servicer perform a mandatory mid-year adjustment to increase charges to customers to correct for undercollections). This voluntary mid-year adjustment helps reduce the volatility of the restructuring charge to customers. The inclusion of an operating reserve account and a debt service account provide sufficient funds to offset the typical variance in collections versus projections in order to meet the projected amortization schedule between true-ups. Affluent ratepayer base: The size, economic stability and diversity of the ratepayer base in the Authority s service area are credit strengths. The service area is fixed by the securitization law and primarily includes the Long Island counties of Nassau and Suffolk, which are two of the most affluent counties in the United States. The service area primarily includes a mix of residential customers (54% by revenue) and commercial customers (43% by revenue). This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 Experienced servicer: LIPA has considerable prior servicing experience with restructuring charges, including acting as servicer for the Authority's three outstanding utility cost recovery charge securitizations. Although LIPA is the named servicer for this securitization, PSEG Long Island LLC (PSEG-LI, unrated), a subsidiary of Public Service Enterprise Group Incorporated (Baa2, positive), will perform LIPA s key servicing duties pursuant to an operations services agreement, including billing and collecting restructuring charges, meter reading and forecasting electricity usage, among others. PSEG-LI currently performs these same functions for the three outstanding utility cost recovery charge securitizations sponsored by the Authority. LIPA will be responsible for the true-up adjustments and certain reporting requirements. Credit Challenges Challenges to securitization law and financing order: Potential state and federal legislative and regulatory actions could weaken the strength of the legal protections of the restructuring property. However, we view this risk as remote. New York does not have a referendum or initiative process by which voters could challenge the securitization law. Therefore, the only way to repeal or amend the securitization law, or for the Authority to amend or revoke the financing order, would be through a legislative action which would violate the state pledge. The risk that the State of New York would take legislative action that compromises its state pledge to the significant detriment of bondholders is remote because state impairment would give rise to claims under state and federal laws prohibiting government impairment of contracts and taking of private property without reasonable reimbursement under state and federal taking claims. The irrevocable and unconditional nature of the financing order mitigates any concern that it could be altered. Several past challenges to securitization laws such as this in other jurisdictions have been unsuccessful. Potential for insufficient collections: Collections arising from the restructuring property could fall short of required distributions on the bonds resulting from inaccurate forecasting of electrical consumption by the servicer, unanticipated delinquencies and defaults, population migration, self-generation and storm damage. The Authority's estimates of market demand, energy prices and growth within its service area could also be inaccurate. These concerns are mitigated by the mandatory uncapped true-up adjustment mechanism, by which the servicer is required to adjust the charges periodically throughout the year to ensure timely payment of the bonds. These true-up adjustments are required to occur annually and can occur semi-annually and at the discretion of the servicer on an interim basis as needed. Relatively high restructuring charge: The Authority expects the securitization s initial restructuring charge to represent around 2.55% of the total monthly bill that a 1,000 kilowatt hour (kwh) residential customer in the Authority's service area will receive as of June 15, The initial restructuring charge for the 2016B transaction, combined with the current restructuring charge for the 2013, 2015 and 2016A transactions, is expected to represent approximately 7.8% of a 1,000 kwh residential customer s bill. This percentage charge is relatively high compared to charges in other utility cost recovery bond transactions. For context, the three most recent utility cost recovery bond issuances we rated, Duke Energy Florida Project Finance, LLC, Entergy New Orleans Storm Recovery Funding I, LLC, and the Louisiana Utilities Restoration Corporation Project/ ELL, had a cumulative (including prior utility cost recovery charges to the same customer base) initial recovery charge amounting to 2.5%, 2.5%, and 3.7% of a 1,000 kwh residential bill, respectively. A high cumulative recovery charge could incentivize a legal challenge to the restructuring charges or the securitization law, or could increase political pressure to rescind or change the securitization law through legislation. This concern is mitigated by the Authority's securitization offset rider, which reduces the Authority's delivery charge in an amount equal to any increase in the restructuring charge to keep customers total monthly bills stable. 3

4 Key Characteristics Asset Characteristics (as of 15 June 2016) Exhibit 2 Asset Characteristics Assets: Restructuring property, which consists of all rights and interest of the issuer under the financing order, including the right to impose, bill, collect and receive irrevocable, binding, nonbypassable charges based on the usage of electricity from all existing or future customers receiving transmission or distribution service from the Authority or its successors or assignees The Authority's service area covers approximately 1.1 million residential, commercial customers in Nassau and Suffolk counties* and the Rockaway Peninsula Service Area: *Excludes the Nassau County villages of Freeport and Rockville Centre and the Suffolk County village of Greenport Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016, and Moody s Investors Service Securitization Structure Characteristics Exhibit 3 Securitization Structure Characteristics Securities Offered: Amount: Structure: Credit Enhancement: Tax-exempt, fixed rate bonds with semi-annual payments $475,000,000* Discrete trust Mandatory uncapped true-up mechanism; operating reserve account (0.5%); debt service reserve account (1.5%) Transaction Parties Sponsor/Depositor/Servicer: Issuer: Transmission and Distribution System Manager: Trustee: Long Island Power Authority (Baa1 stable) Utility Debt Securitization Authority PSEG Long Island LLC (unrated) The Bank of New York Mellon Trust Company, National Association (Aa1/Aa2 stable, a1)** *Preliminary and subject to change based on market conditions **The bank ratings shown in this report are the banks deposit ratings and senior unsecured debt ratings and outlooks, and their baseline credit assessments Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016, and Moody s Investors Service 4

5 Assets Overview The collateral for this pool is the restructuring property, consisting of the irrevocable contract right to impose, bill and collect nonbypassable consumption-based restructuring charges from all existing and future retail electric customers taking electric transmission or distribution service within the Authority's service area. The bonds are also secured by funds on deposit in the collection account, including the debt service reserve subaccount and the excess funds subaccount, by the issuer s rights under the various transaction documents, by the issuer's right to compel the servicer to file for and obtain true-up adjustments, and by all payments on or under the pledged collateral and by all proceeds with respect to the pledged collateral. Assets Description The Securitization Law The purpose of the securitization law is to create the issuer and allow the Authority to finance the retirement of a portion of its outstanding debt through the issuance of restructuring bonds by the issuer, resulting in savings to the Authority's customers on a net present value basis. The securitization law gives the Authority the right to impose restructuring charges, which is the key asset backing this securitization. The securitization law, coupled with the adoption of additional financing orders, authorizes the Authority to create additional restructuring property as collateral for the issuance of bonds. The Authority will use this issuance to retire a portion of its outstanding debt and financing costs, including the costs of issuing, supporting and servicing the bonds. The current financing order allows for an aggregate amount not to exceed $4.5 billion (inclusive of the previously-issued bonds: $2,022,324,000 in 2013, $1,002,115,100 in 2015 and $636,770,000 in 2016). After the Series 2016B issuance, the issuer has capacity issue an additional $363.8 million of restructuring bonds under the initial authorization. Similar to other utility cost recovery charge securitizations, this securitization benefits from the securitization law s inclusion of a state non-impairment pledge, subject to the true-up mechanism, that is incorporated into the securitization documents for the benefit of the trustee on behalf of bondholders. A breach of such pledge triggers an event of default under the indenture. The Financing Order On June 26, 2015, the Authority adopted Financing Order No. 4 (the financing order), together with Financing Order No. 2 and Financing Order No. 3; all of which were approved by the New York Public Authorities Control Board on July 15, On August 14, 2015, the financing orders became irrevocable, final and non-appealable. Each financing order authorizes restructuring bonds that will be secured by a separate restructuring property that would be created pursuant to that financing order. Similarly, the Series 2013 restructuring bonds that the issuer issued pursuant to Financing Order No. 1 are secured by the 2013 restructuring property, the Series 2015 restructuring bonds that the issuer issued pursuant to Financing Order No. 2 are secured by the 2015 restructuring property and the Series 2016A restructuring bonds that the issuer issued pursuant to Financing Order No. 3 are secured by the 2016A restructuring property. The issuer is issuing the bonds pursuant to the financing order, which authorizes: 1) the creation of the restructuring property; 2) the Authority to sell the restructuring property to the issuer under the financing order (the restructuring property is created simultaneous with its sale to the issuer); 3) the imposition, billing and collection of restructuring charges on, to and from the customers in the service area; 4) the issuance of the bonds by the issuer; 5) the issuer to use the bond proceeds to purchase the restructuring property from the Authority and pay upfront financing costs; and 6) the Authority to use the proceeds of the sale of the restructuring property to retire a portion of its outstanding debt. The securitization law provides that the financing order is irrevocable and is not subject to modification or termination. The financing order acknowledges the state pledge. Prior to the issuance of the bonds, the financing order requires the servicer to file an issuance advice letter with the Authority setting forth: 1) the expected savings to customers from the securitization; 2) the estimated ongoing financing costs; 3) the initial restructuring charge; and 4) the final terms of the bonds. The financing order authorizes a designee of the Authority to review and approve the 5

6 issuance advice letter for the purpose of confirming that the stated terms are consistent with the financing order. The designee s approval will be final and incontestable. The State Pledge The securitization law includes a pledge from the State of New York to the bondholders that it will not (1) take or permit any action that limits, alters or impairs the value of restructuring property; or (2) reduce, alter or impair transition charges that are imposed, collected and remitted for the benefit of the owners of restructuring bonds, any assignee, and all financing entities, until any principal, interest and redemption premium in respect of restructuring bonds, all ongoing financing costs and all amounts to be paid to an assignee or financing party under an ancillary agreement are paid or performed in full, except as required by the adjustment mechanism described in the restructuring cost financing order. Any action of the New York legislature adversely affecting the restructuring charges or the ability to impose, charge or collect the restructuring charges would likely require the State of New York to pay just compensation under the takings clause of the United States and State of New York Constitutions. The state pledge provides protection to bondholders. To the extent the Authority or the State of New York have obligations under the financing order (e.g. to file for true-up adjustments), the securitization law provides that the owner of the restructuring property (the issuer), or the trustee representing the bondholders, are expressly permitted to bring actions for enforcement of the financing order. The Restructuring Charges Under the financing order, the servicer (on behalf of the issuer as owner of the restructuring property) has the right to impose, bill and collect irrevocable and nonbypassable restructuring charges from all of the Authority's customers in an amount sufficient to: 1) pay interest on the bonds when due and principal of each tranche of bonds according to the related expected amortization schedule; 2) pay the fees and expenses of the securitizations service providers; and 3) replenish the operating reserve and debt service reserve subaccounts to the required levels. There is no cap on the level of restructuring charges that the servicer may impose on ratepayers through the true-up adjustment mechanism. This is designed to ensure the expected collection of amounts sufficient to timely pay the amounts specified above. Accordingly, the restructuring charges may continue to be imposed and collected until the bonds are repaid in full, without any specified time limit. The financing order authorizes the servicer to collect restructuring charges directly from the Authority s customers. The restructuring charge will be the same for all customer classes. Under the securitization law, the charges and any adjustments thereto are not subject to review or regulation by the New York State Department of Public Service, the staff arm of the New York Public Service Commission. The restructuring charges are nonbypassable; nonbypassable as set forth in the securitization law and the financing order means that the customer is obligated to pay the restructuring charges (and may not legally avoid payment of such charges) as long as such customer is connected to the transmission and distribution (T&D) system assets (the Authority's delivery system, which includes transmission and distribution lines and substations) and is taking electric delivery service in the service area, even if such customer produces its own electricity or purchases electric generation services from a provider of electric generation services other than the owner of the T&D system assets and even if the Authority no longer owns the T&D system assets. Thus, the only way customers can avoid restructuring charges is if they are fully cut off from the T&D system assets. The Service Area The Authority provides electric T&D services in its service area which includes two counties in Long Island, NY Nassau County and Suffolk County (except for the Nassau County villages of Freeport and Rockville Centre and the Suffolk County village of Greenport, each of which has its own municipal electric system) and a small portion in Queens, NY known as the Rockaways. The population of the service area is around three million. The securitization law defines the service area as the geographical area within which the Authority provided electric T&D services as of July 29, Thus, the service area is fixed by the legislation. 6

7 As of December 31, 2015, the service area included approximately 1.1 million customers. In 2015, retail electric usage was 54.4% residential, 43.5% commercial, 0.7% street lighting and 1.5% other public authorities. Exhibit 4 below shows the service area. Exhibit 4 LIPA Service Area Source: PSEG-LI website Statutory Uncapped True-Up Adjustment Mechanism Under the securitization law and the financing order, the servicer will adjust the restructuring charges through the securitization s trueup mechanism to ensure timely bond payments. The adjustments to the charges will continue until the bonds are repaid in full and there is no cap on the amount of charges that may be imposed on customers resulting from the adjustments. The mechanics of the true-up adjustments are as follows: 1. Initial true-up adjustment to the restructuring charges will be made on November 15, Standard mandatory annual adjustments to the restructuring charges to correct for any over-collections or under-collections to date and anticipated to be experienced up to the date of the next annual adjustment and to ensure that the expected collections are sufficient to timely pay interest and scheduled principal (according to the expected amortization schedule) on the bonds and all other ongoing financing costs 3. Mandatory semiannual adjustments to the restructuring charges only if the servicer forecasts that charge collections will be insufficient to ensure timely payment of interest and scheduled principal on the bonds and all other ongoing financing costs 4. Voluntary semiannual adjustments to decrease the restructuring charges to customers if the servicer forecasts that charge collections will be greater than the amount required to ensure timely payment of interest and scheduled principal on the bonds and all other ongoing financing costs 7

8 5. More frequent adjustments at any time without limits as to the frequency to ensure that the expected charge collections are adequate to ensure timely payment of interest and scheduled principal on the bonds and all other ongoing financing costs 6. After the last scheduled maturity date of the bonds (of any series), quarterly adjustments to ensure that charge collections will be sufficient to timely pay interest and principal on the next payment date, in addition to all other ongoing financing costs; the adjustments will be set at levels estimated to generate revenues sufficient to fully repay the bonds on the next payment date, plus all other ongoing financing costs All adjustments will be designed to cause: 1) the outstanding principal balance of the bonds (or any series of bonds) to be equal to the scheduled balance (based on the expected amortization schedule); 2) the amount in the operating reserve and debt service reserve subaccounts to be equal to the required levels; and 3) with respect to the annual true-up only, any amount in the excess funds subaccount to be equal to zero by the payment date immediately preceding the effective date of the next annual adjustment. Servicing LIPA, acting as servicer under the servicing agreement, or any successor servicer as the financing order provides, will be responsible for servicing the restructuring property, including: 1) obtaining meter reads; 2) forecasting electricity usage; 3) calculating, billing and collecting the restructuring charges; 4) processing, accounting for and depositing charge collections and making periodic remittances; 5) calculating and implementing the true-up adjustments to the restructuring charges; 6) investigating and handling delinquencies and selling defaulted or written off accounts; 7) responding to inquiries from customers, the Authority, or any governmental authority regarding the restructuring property and the restructuring charges; and 8) furnishing periodic reports and statements. Although LIPA is the named servicer for this securitization, PSEG-LI, a subsidiary of Public Service Enterprise Group Incorporated (PSEG, Baa2 positive), will perform LIPA s key servicing duties pursuant to an operations services agreement, including billing and collecting the restructuring charges, meter reading and forecasting electricity usage, among others. PSEG is a publicly traded energy and energy services company. As of December 31, 2015, it had total assets of approximately $37.5 billion, last twelve months revenues of approximately $10.4 billion; and employed approximately 13,000 people. PSEG is the parent holding company of PSEG Power LLC, New Jersey's largest wholesale merchant generator with approximately 13.1 GW of capacity; Public Service Electric and Gas Company, New Jersey's largest regulated electric and gas T&D utility; and PSEG Energy Holdings L.L.C., which owns a portfolio of leveraged leases and is also pursuing investments in renewable generation. There is no named backup servicer at closing though the financing order allows for a replacement servicer if the current servicer defaults in its performance obligations. In addition, the financing order allows the servicing fee to step-up from 0.05% to 0.60% of the initial principal balance of the bonds if LIPA is replaced as servicer by a successor servicer not affiliated with the owner of the T&D system assets. Billing PSEG-LI will perform LIPA s duties of billing and collecting the restructuring charges, meter reading and forecasting electricity usage. LIPA will be responsible for the true-up adjustments and certain reporting requirements. Under the securitization law and the financing order, if and to the extent that third parties are allowed to bill and/or collect any restructuring charges in the future while the bonds are outstanding, LIPA, any successor servicer, and any owner of the T&D system assets will take steps to ensure nonbypassability and minimize the likelihood of default by third-party billers. Further, LIPA and any successor servicer will not permit implementation of any third-party billing or collection that would result in a reduction or withdrawal of the current ratings on the bonds. The provision of electric service to customers by LIPA is governed by the Home Energy Fair Practices Act (HEFPA). LIPA s credit and collections practices, including the ability to terminate (disconnect) service, are governed by HEFPA. Exhibit 5 below shows net write-offs since 2010, which have ranged from a low of 54bps of billed revenue in 2013 to a peak of 67bps in 2011 and

9 Exhibit 5 Net Write-Offs as a Percentage of Billed Retail Revenues Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016, and Moody s Investors Service Exhibit 6 below shows LIPA customer delinquency data since Exhibit 6 Average Monthly Delinquencies as a Percentage of Total Billed Revenues Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016, and Moody s Investors Service 9

10 Assets Analysis Legal Analysis Under the laws of New York and the United States, New York could not constitutionally take any legislative action, including the repeal or amendment of the securitization law, which would substantially limit, alter or impair the restructuring property or other rights vested in the bondholders pursuant to the financing order or substantially limit, alter, impair or reduce the value or amount of the restructuring property, unless (1) such action is a reasonable exercise of the State of New York s sovereign powers that appropriately furthers a legitimate public purpose; and (2) if such action constituted a permanent appropriation of the bondholders substantial property interest in the restructuring property and deprived them of their reasonable expectations arising from their investments in the bonds, under the takings clauses of the federal and New York Constitutions, New York could not take such action without paying just compensation to the bondholders as determined by a court of competent jurisdiction. New York does not have a referendum or initiative process by which the securitization law may be challenged. Therefore, the only way for the securitization law to be changed would be through a legislative action which would be subject to the state pledge. Bondholders (or the trustee acting on their behalf) could challenge under the Contract Clause of the United States Constitution the constitutionality of any repeal or amendment of the securitization law or any other action or failure to take any action required by the state pledge that limits, alters or reduces the value of the restructuring property or the restructuring charges before the bonds are repaid in full, unless such action is necessary to further a significant and legitimate public purpose. Under existing case law, assuming the takings clause applies under the federal and New York Constitutions, respectively, the State of New York would likely be required to pay just compensation to the bondholders if the State undertook a repeal or amendment of the securitization law or took any other action or failed to take any action required by the state pledge before the bonds are repaid in full that: 1) permanently appropriates the related restructuring property or denies all economically productive use of the related restructuring property; 2) destroys the restructuring property, other than in response to emergency conditions; or 3) substantially reduces, alters or impairs the value of the restructuring property so as to unduly interfere with the bondholders reasonable expectations arising from their investments in the bonds. The financing order provides that the restructuring property may be pledged to secure the payment of the bonds, financing costs, and other amounts owed. The securitization law provides that a valid and enforceable security interest in the restructuring propery will attach and be perfected at the time the pledge is made. The lien and security interest attach without any physical delivery of collateral or other act. The securitization law provides that the pledge is continuously perfected and has priority over any other lien created by the operation of law or otherwise that may be created subsequently. Strong Service Area Long Island s economy benefits from a highly skilled labor force, close proximity to New York City, more than 20 colleges and universities and core research institutions. Long Island s median household income is substantially above that of New York State and the US. According to estimates from the US Census Bureau, the 2014 median household income for Nassau County and Suffolk County was $99,035 and $86,266, respectively, considerably higher than the $58,878 for New York State and the $54,562 for the US. According to the Authority, while the cost of electricity in the service area is higher than the national average, the cost of electricity as a percentage of income is below the national average. Exhibit 7 below shows the percentage of total billed revenue attributable to each customer class since

11 Exhibit 7 Sales by Revenue Class (% of Total Billed Revenue) Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016, and Moody s Investors Service For the twelve months ending on June 30, 2016, the ten largest retail electric customers represented approximately 5.7% of the Authority's retail kilowatt-hour sales resulting in 4.8% of revenues. As of the closing date, no customer or group of related commercial is exempt from paying the restructuring charges. Exhibit 8 below shows the energy usage and revenue from the top 10 commercial customers. Exhibit 8 Top 10 LIPA Commercial Customers Source: Utility Debt Securitization Authority Remote Risk of Severe Ratepayer Base Declines The Series 2016B bonds are exposed to the risk of declines in the ratepayer base in the service area. However, declines in the ratepayer base dramatic enough to impact the rating of the bonds are unlikely given the size, projected population growth and economic stability of the service area s stable ratepayer base. We view the risks to the transaction of ratepayer base declines due to any of these factors to be low. Self-Generation We look at the potential for increased use of self-generation as a minor headwind to the transaction. Self-generation, which primarily includes solar, reduces the ratepayer base and increases the burden of restructuring charges on other non-self-generating ratepayers. Customers that self-generate will only be responsible for paying restructuring charges based upon their net-billed consumption. The securitization law and financing order do not provide for exit fees to be charged to any customers that might leave the grid to selfgenerate. Change in Service Area We look at the risk of a ratepayer base decline due to a change in the service are to be minimal. The restructuring charge will be recoverable from all customers taking T&D service. As of July 29, 2013, the securitization law defines the service area to include two counties in Long Island, NY Nassau County and Suffolk County (except for the Nassau County villages of Freeport and Rockville Centre and the Suffolk County village of Greenport, each of which has its own municipal electric system) and a small portion in Queens, NY known as the Rockaways. Thus, the service area is fixed by the legislation. If the service area expands in the future, the new customers would be subject to the restructuring charge on a going-forward basis. 11

12 Municipalization We view the risk to the ratepayer base due to municipalization as low due to the nonbypassability of the charges. Moreover, municipalization would not affect restructuring charge collections since a successor and its customers will be subject to the restructuring charges, even if the T&D system assets are no longer owned by the Authority. Since 1998, no municipalizations have occurred in the service area. Storm Damage We view the risk of reduced collections due to weather to be low, and substantially mitigated via the true-up mechanism. Hurricanes, tropical storms or wind storms may impact the Authority's operations, temporarily interrupting transmission, distribution and consumption of electricity, hence reducing the collections of restructuring charges. There might be longer-lasting weather-related adverse effects on residential and commercial development and economic activity in the Authority's service area, which could cause the per-kwh restructuring charge to be greater than expected. Forecasting Electricity Consumption The Authority's internal company forecasts are used for projections of electricity price and weather conditions. The forecast incorporates customer usage, delinquencies and write-offs, among other inputs. The Authority assesses the restructuring charges based on its forecasts of customer usage. The amount and the rate of restructuring charge collections will depend in part on actual electricity consumption and the amount of collections and write-offs. Exhibit 9 below shows the forecasted restructuring charge per 1,000 kwh and scheduled debt service payments. Exhibit 9 Restructuring Charge and Debt Service ($ per 1,000 kwh)* *Preliminary and subject to change based on market conditions Source: Utility Debt Securitization Authority; Moody's calculations Forecast Variance For there to be insufficient funds to pay ultimate principal and timely interest on the bonds, there would need to be unexpected, persistent and extensive drops in electricity consumption. Additionally, there may be insufficient funds if the servicer inaccurately forecasts electricity consumption or uses inaccurate customer delinquency or charge-off data when setting or adjusting the 2016B restructuring charges. We view this risk as remote, as the maximum forecast variance since 2011 has been less than 6% per customer category, as shown in Exhibit

13 Exhibit 10 Annual Forecast Variance for Ultimate Electric Delivery (% of Forecast) Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, 2016 Cash Flow Analysis We examined the cash flows that the restructuring charges will generate under various scenarios. In light of the strength of the ratepayer base, the purpose was primarily to see how high the restructuring charges can go as a percentage of a 1,000 kwh residential customer s bill and also to illustrate how the restructuring charges behave under various stress scenarios of customer demand. Our rating is primarily based on qualitative analysis of the political, legal and regulatory aspects of the securitization and the strength of the ratepayer base. However, we run these stress scenarios to confirm that the level of the restructuring charges is consistent with other comparable transactions. Even if the financing order is irrevocable, the restructuring charges or the law that authorizes them could be subject to challenge in the courts or to future political pressure to rescind or change them through legislation. Such challenge is more likely the higher the charges, i.e., the more the economic incentive for a challenge, or in circumstances where the financial imbalances in a utility system increase. Consequently, our economic analysis focuses on the size of the restructuring charge, both in absolute terms and as a percentage of the customer s energy bill. In our more extreme scenarios, the percentage of a residential customer s monthly bill devoted to the restructuring charge is as high as 22.74%, higher than most other utility cost recovery charge securitizations. This concern is mitigated by the Authority's securitization offset rider, which reduces the delivery charge in an amount equal to any increase in the restructuring charge to keep customers total monthly bills stable. The Authority expects the combined initial restructuring charge for the 2013, 2015, 2016A and 2016B transactions to be around 7.8% of the total monthly bill that an average 1,000 kwh residential customer in the service area would receive as of June 15, 2017, which is higher than most other utility cost recovery charge securitizations we rate. The 7.8% is preliminary and subject to change based on market conditions. We looked at three scenarios: Scenario Description and Projected Output Base Scenario 1. Electricity consumption as per the Authority's projections 2. Implied net charge-offs of 0.62% 3. Collection curve projects 20.0% of collections within 30 days and 80.0% of collections between days 4. Servicing fee is 0.05% on an annualized basis of the original principal amount of bonds so long as the servicer remains LIPA or an affiliate. While a back-up servicer has not been retained, the issuer can increase servicing fees to 0.60% to attract one if needed. Stress Scenario 1 1. Electricity consumption decreases linearly by 5% every year until it reaches 50% of the projected consumption for residential customers and 65% for non-residential customers 2. Annual net charge-offs are the same as in base case 3. Collection curve is the same as in base case 13

14 4. Loss of 100% of the collections from the peak consumption month and 50% of the collections from the second highest consumption month each year 5. Replacement servicing fee of 0.60% per year of the initial bond balance with other expenses the same as in the base case Stress Scenario 2 1. Electricity consumption is reduced by 25% permanently against the first year base case projection 2. Annual net charge-offs the same as in base case 3. Collection curve is the same as in base case 4. Servicing fee and all other fees the same as in base case For all of the scenarios, the bonds are fully paid by their legal final maturity dates. Exhibit 11 shows the projected restructuring charge as a percentage of a 1,000 kwh residential customer s total bill, and Exhibit 12 shows the projected restructuring charges for customers per 1,000 kwh over the securitization s life. The periodic variance in the charges under the stress scenarios is due to the semiannual true-ups capturing seasonality in electricity usage. Exhibit 11 Projected Restructuring Charge as a Percentage of a Customer's Total Bill Source: Utility Debt Securitization Authority; Moody's calculations Exhibit 12 Projected Restructuring Charge ($ per 1,000 kwh) Source: Utility Debt Securitization Authority; Moody's calculations 14

15 Comparables As shown in Exhibit 13, stress scenario 1 is more stressful and results in a peak restructuring charge equal to about 22.74% of a 1,000 kwh per month customer s bill. This is high compared to other utility cost recovery deals. Exhibit 13 Maximum Recovery Charge Comparison (% of a 1,000 kwh Customer's Bill) Source: Moody's Securitization Structure Overview On the closing date, the Authority will sell the restructuring property to the issuer pursuant to a sale agreement between the issuer and the Authority. LIPA will be the servicer of the restructuring property. PSEG-LI will perform LIPA s key servicing duties pursuant to an operations services agreement, including billing and collecting restructuring charges, meter reading and forecasting electricity usage, among others. Securitization Structure Description Structural Diagram Exhibit 14 below illustrates the relationships between the transaction parties and bondholders. Exhibit 14 Structural Diagram Source: Utility Debt Securitization Authority, Restructuring Bonds, Series 2016B Preliminary Official Statement dated July 28, The issuer purchases the restructuring property from the Authority and issues the Series 2016B bonds 2. The issuer contracts with LIPA as servicer to calculate and adjust the restructuring charges 3. LIPA contracts with PSEG-LI to bill and collect the restructuring charges 15

16 4. Electric utility customers pay restructuring charge on electricity bills based on electricity consumption 5. The Authority, as allocation agent, remits the restructuring charges to the trustee on a daily basis Detailed Description of the Structure Credit Enhancement Credit enhancement for the bonds will be provided by the true-up mechanism, as well as by the debt service reserve account. The primary purpose of the excess funds subaccount is not to provide credit enhancement for the bonds but to hold funds collected in amounts that were more than necessary to pay current debt service. However, amounts in the excess funds subaccount may be used to make debt service payments on the bonds when needed. Operating Reserve Account On or before the date of issuance of the bonds, the Authority will deliver to the trustee for deposit into the operating reserve account an amount not less than 0.50% of the initial aggregate principal amount of the Series 2016B bonds. Amounts may be withdrawn from the account to pay scheduled principal on the Series 2016B bonds, provided however that an amount not less than 0.50% remains on deposit in the account. Debt Service Reserve Account On or before the date of issuance of the bonds, the issuer will make a capital contribution to the trustee in an amount not less than 1.5% of the aggregate outstanding principal amount of the bonds, which will be deposited in the debt service reserve account. Under the financing order, any funds in the debt service reserve subaccount in excess of the required debt service reserve level shall be retained in the subaccount and applied to subsequent payments. Cash Commingling The servicer is entitled to commingle the restructuring charges that it receives with its own funds until it remits the funds to the indenture trustee on a daily basis. The securitization law provides that the priority of a lien and security interest is not impaired by the commingling of funds arising from restructuring charges with other funds. No less often than annually, the servicer and the indenture trustee will reconcile remittances of estimated recovery charge collections with actual payments received. To the extent the remittances of estimated payments exceed the amounts that should have been remitted, the servicer will be entitled to withhold the excess amount from any subsequent remittance. To the extent the remittances of estimated payments are less than the amount that should have been remitted, the servicer will remit the amount of the shortfall to the allocation account within two business days. Any discrepancy between estimated and actual collections is mitigated by the true-up mechanism, which allows the Authority to adjust the restructuring charges at any time as needed to make timely interest and principal payments on the bonds. Payment Priority On each semiannual payment date, or for items 1 through 4 below, on any business day, the trustee will pay or allocate, at the direction of the servicer, all amounts on deposit in the collection account in the following order of priority: 1. to the trustee, i) all fees, expenses and ii) any outstanding indemnity amounts not to exceed $800,000 in each year; 2. to the servicer, the servicing fee and all prior unpaid servicing fees, capped at 0.60% of the aggregate principal balance of the bonds in each year; 3. to the administrator, the administration fee ($100,000 per year) and all prior unpaid administration fees; 4. the payment of all other operating expenses to the persons entitled to such payment; 5. to the bondholders, first, any overdue interest (together with, to the extent lawful, interest on such overdue interest at the applicable bond interest rate) and second, interest due on such payment date; 6. to the bondholders, principal due and payable on the bonds as a result of an event of default and an acceleration of the bonds or on the legal final maturity date of a tranche of bonds; 16